Price Protection
This newsletter is a copy of today’s Klarenbach Hog Report, where I discuss Lean Hog, grain and currency futures.
This newsletter considers Lean Hogs; however, it applies to all commodities and currencies.
I hope that you enjoy this perspective and share it with others
Price Protection
Let us discuss how we can use trend identification and various tools to protect prices.
As hog producers, our buyer basically provides two pricing options:
Spot delivery price; or
Forward Pricing Contracts.
These pricing options are attractive in different situations.
For example:
Spot delivery is attractive while prices are trending higher.
Forward Pricing Contracts are attractive while prices are trending lower.
Trend Identification
Now the question is, how do we determine the direction of a trend?
Higher highs and higher lows define an uptrend.
Lower highs and lower lows define a downtrend.
If the trend is up, we want to stay with that trend until it changes.
If the trend is down, we want to exit our long position or protect against further downside.
Pricing Strategies
If the price is trending down, we want to either;
Forward price our sales; or
Hedge our position by selling Futures contracts until we sell the physical.
Hedging
What is Hedging?
The Investopedia website defines hedging with the following.
Hedging is a way to reduce risk exposure by taking an offsetting position in a closely related product or security.
Hedging with futures effectively locks in the price of a commodity today, even if it will actually be bought or sold in physical form in the future.
Pros of Hedging
A major attraction of the Future’s market is the price discovery and liquidity it provides.
One of the drawbacks of the forward price contract offered by the buyer is the inability to exit the position when the market changes or if we are wrong in our trade.
We need to be prepared for the price to move against us.
Forward pricing with the buyer is great if we are satisfied with the price and our expenses are managed.
But what if we are wrong?
The position is difficult to be reversed.
On the other hand, hedging with futures contracts allows the flexibility to enter and exit positions upon a change in the direction of the trend.
Cons of Hedging
Cash is required to maintain a margin with the broker; and
Margins calls can be devastating
Margin Calls
What are Margin Calls?
A margin call occurs when the value of an investor's margin account falls below the broker's required amount.
A major concern with Futures contracts is the dreaded Margin Calls.
How do we minimize or avoid margin calls?
Before entering a trade or making an investment, one should identify both our entry price and where we exit if the trade is wrong.
A common exit for a short position is upon a higher high on your timeframe.
Without a preplanned stop in place, excessive losses occur, margin calls happen, and accounts get destroyed.
We want to eliminate margin calls.
Strategy Update
Last week, I emailed our local hog producer, discussing a possible change in the trend and my strategy to protect prices.
These trend change signals are also a great time to forward price favourable prices with your buyer.
Let us look at some charts:
******Click on the chart to enlarge******
JUNE LEAN HOG FUTURES
The first chart is the June Lean Hog contract emailed to our local hog producer on April 13th to anticipate a potential trend change.
My action plan was to short the June contract in the event of a close below 104.575 on the Daily chart,
Here is today’s chart.
As you can see, the June Daily closed below 104.575, making a new low and a change in the short-term trend.
All trend changes begin with the short-term before moving to the long-term.
One should note and be cautious of the green 50 Day moving Average below in the area of previous support. Hence, the short-term trend change label.
The key to risk management is to identify when your thesis is incorrect and to exit the position.
Yesterday’s long red candle close means a wide stop making risk management difficult.
I will wait for a retrace to the area of the red line before creating a new low to create a lower stop level.
I will handle this differently in the future by placing an advance order to sell at the first price beneath that entry-level.
JULY LEAN HOG FUTURES
I emailed this first chart to our local hog producer, stating that I will be locking in some prices with a Daily close below 103.25.
Here is today’s chart:
I shorted 3 June hog contracts at an average price of 102.35.
Currently, this position has an unrealized P/L of $3150 with the margin requirements of $5940.
Tomorrow, I will move my stop to breakeven, minimizing the need for a margin call.
I will watch how the price reacts at the green 50 Day Moving Average and the purple VWAP.
Often a price reversal occurs at these indicators.
If the price reverses and goes higher, I will flatten the position and enjoy the higher prices on the cash side.
AUGUST LEAN HOG FUTURES
Friday’s daily close made a new low and closed below the green 50 DMA.
The price had quite a drop in the last two days.
I anticipate a bounce at the green 50 DMA and then will reassess.
OCTOBER LEAN HOG FUTURES
The price closed below the green 50 DMA; however, it did not make a new Daily low.
I will continue to assess before taking a position.
That is all for now.
I enjoy discussing the markets, whether they are currencies, equities, commodities, or bonds.
Let’s have a conversation, and we can explore a new perspective of the markets that you can apply to your analysis.
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